Frontdoor Inc

NASDAQ:FTDR

Earnings Call Transcript 2018-Q4

[Operator]

Ladies and gentlemen, welcome to Frontdoor's Fourth Quarter and Full Year 2018 Earnings Call. Today's call is being recorded and broadcast on the Internet. Beginning today's call is Matt Davis, Vice President of Investor Relations and Treasury, and he will introduce the other speakers on the call. At this time, we'll begin today's call. Please go ahead, Mr. Davis.

[Matt Davis, executive]

Thank you, operator. Good morning, everyone, and thank you for joining Frontdoor's Fourth Quarter and Full Year 2018 Earnings Conference Call. Joining me on today's call are Frontdoor's Chief Executive Officer, Rex Tibbens; and Frontdoor's Chief Financial Officer, Brian Turcotte.

Before I review the agenda and turn the call over to Rex and Brian, at about 6:00 a.m. Central Time today, Frontdoor issued a press release reporting our fourth quarter and full year 2018 financial results. The purpose of today's call is to provide investors with further details regarding Frontdoor's financial results as well as provide a general update on the company's progress. The press release and a slide presentation that will be utilized during today's call can be found on the Investors Relations section of Frontdoor's website, which is located at www.frontdoorhome.com. I would also encourage all of our listeners to visit our website to find out more about our company.

As stated on Slide 2 of the presentation, I'd like to remind you that this call will contain forward-looking statements. Investors should be aware that any forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the company's filings with the Securities and Exchange Commission. Please refer to the Risk Factors section of our filings for a more detailed discussion of forward-looking statements and the risks and uncertainties of such statements.

All forward-looking statements are made as of today, February 27, and except as required by law, the company undertakes no obligation to publicly update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

We'll reference certain non-GAAP financial measures throughout today's call, and we have included definitions of these terms in our press release and the appendix of this presentation. We've also included reconciliations of these non-GAAP financial measures to the most comparable GAAP financial measures in our press release and the appendix of this presentation in order to better assist you in understanding our financial performance.

Our financial statements include all revenues, costs, assets and liabilities directly attributable to us. Additionally, our financial statements for periods prior to the spin-off, which occurred on October 1, 2018, include allocation of certain costs from ServiceMaster incurred on our behalf. For those following along with the presentation available on our website, I'll walk through the agenda items shown on Slide 3.

Frontdoor's CEO, Rex Tibbens, will lead off by providing a review of our full year 2018 summary. He will then provide a business update and discuss our strategic priorities for 2019. Brian Turcotte, Frontdoor's CFO, will follow and will summarize our fourth quarter and full year 2018 financial results, provide more details in regard to our financial statements and then speak to the full year 2019 outlook. We will then open up the line for questions.

I'll now turn the call over to Frontdoor's CEO, Rex Tibbens, for opening comments. Rex?

[Rexford Tibbens, executive]

Thank you, Matt, and good morning, everyone.

Let's start with our full year 2018 summary shown on Slide 4. I'm pleased to report that we finished the fourth quarter and full year on a stronger note than our revised outlook provided during the third quarter earnings call in early November, with revenue at the higher end of the guidance range and EBITDA above the range.

Full year revenue increased 9% to a record $1.26 billion in 2018. We also reported better-than-expected adjusted EBITDA of $238 million and adjusted EBITDA margin of 19% for 2018, which Brian will expand on later.

Continuing down Slide 4, our business continues to grow at a strong rate. As a leader in the U.S. home service plan industry, we continue to grow the number of home service plans, increasing 6% to 2.1 million plans.

Complementing our home service plan growth, we had strong customer retention rate of over 75% in 2018, up 30 basis points year-over-year. We also continue to execute on the key strategic initiatives and process improvements to drive our business results, which I outlined on the third quarter earnings call. I will provide additional detail on these initiatives as well as our 2019 objectives in a moment.

On the people front, we added a new member to our strong leadership team. In December, Piras Thiyagarajan joined as our Chief Technology Officer. Piras brings more than 20 years of experience with some of the world's most recognized technology companies and holds 6 U.S. patents for data security, transaction and technology systems. Piras recently served as Vice President of Engineering and Technology for RideCell, a Silicon Valley start-up. He previously served as Director of Engineering for Google and has held senior management roles in Amazon where he led the development and execution of new global customer delivery experiences.

As evidenced by our recent hires, our management team has the experience to shape Frontdoor's vision for the future. We're laying the foundation for a much stronger and more dynamic company that is intensely focused on improving the core business and building our future platform. We are laser-focused on taking the hassle out of your home and this will be our north star as we continue to build and transform the company.

Moving to Slide 5, let's discuss our 3 primary revenue channels: direct-to-consumer or DTC, real estate and renewals. First year DTC sales accounted for 12% of our overall revenue in 2018 as we continue to successfully grow our customer base through targeted marketing and a focused approach to differentiating ourselves from the competition through products and services that we offer. We are currently implementing new marketing strategies to increase the efficiency of our advertising dollars and to drive DTC sales in 2019 through our digital, social, direct mail and broadcast channels. Given the DTC's customers direct intent to purchase, this channel produced its high first year renewal rates of approximately 75%.

First year real estate sales accounted for 21% of our 2018 overall revenue. While existing market reports indicate U.S. home sales declined 3% to 5.3 million homes last year, we're encouraged by the current market environment of lower interest rates, higher home inventory and stabilized medium home price.

Regardless of the macroenvironment, our real estate team is focused on increasing business in all real estate markets. To accomplish this goal, we're renewing the focus on our core markets and continuing to foster relationships with the leading brokerage firms.

We are focused on driving further channel penetration through these partnerships. We're also taking a more analytical approach to how we spend our sales dollars in the real estate space, allowing us to pinpoint specific geographic opportunities, which drive efficient growth.

First year real estate renewals are a big opportunity for us, and as such, a focal point for 2019.

Renewals, our largest channel, accounted for 66% of our overall revenue in 2018. These are customers that originated in either the DTC or real estate channel and already renewed service at least once with us.

In order to further increase our first year real estate renewal rates, we're taking several steps to improve the move-in experience. The rekey initiative for new homeowners, which began last year, is a prime example of the high-value services we are looking to add to the products we offer. We have now seen that rekey customer retention rates are 10% higher than those who do not use the service, and we're excited about more homeowners taking advantage of this service.

These additive programs aren't just convenient for the customer but are a significant steps towards improved customer retention and satisfaction.

Further, we're also developing a cross-functional retention plan to enhance the customer onboarding experience; reduce payment friction by expanding conversion of evergreen contracts and auto payments; add more services to our home service plans; and enrich the core service experience. While I'm pleased we continued to increase our customer retention rates, this too will be an area of focus for 2019.

Now please turn to Slide 6 where I will discuss our 2019 strategic objectives, which focus on strengthening our core business to enable continued growth, continue our cost-containment initiatives and powering our on-demand offering.

As I mentioned earlier, we have made good progress on the 4 focus areas we had in 2018. We have included these and expanded our objectives for 2019. We expect to make significant progress on these objectives over the next 6 to 12 months.

Our first strategic objective relates to improving the customer experience. As I mentioned when discussing the renewal channel, we're focused on enhancing the customer experience and making it more convenient for our customers to interact with both Frontdoor and our contractors when they need service. Specifically, we are in the process of rolling out new software in our customer care centers, which is more intuitive, user-friendly and data-rich than the current software utilized by our customer care agents.

We believe the conversion will not only provide a positive step in our customer experience, but also allow our customer care agents to process more calls and claims with greater effectiveness and efficiency.

Additionally, towards the end of 2019, we'll be establishing pilots to test artificial intelligence technology to better help customers, answer questions or provide status on their service request.

Over the course of the year, we'll be considering revisions to make our customer agreements as simple and easy to read as possible. We believe it's important that our customers be able to easily understand the protection the home service plan provides.

Our second strategic objective is related to enhancing the pricing process. As we reviewed on the third quarter earnings call, we have strategically raised prices for all products across all channels. The overall average price increase was in the mid-single-digit range, well above our typical increase of low single digits. We have now fully implemented all of our pricing increases with DTC completed in the fall and AHS real estate, where we have not implemented an increase in nearly 3 years, completed this month.

We are already seeing some favorable impact from the price increases implemented last year, with attrition rates at or better than originally forecasted across all channels.

Related to pricing increases, I would like to remind you that our subscription-based pricing model provides strong, stable and predictable revenue. And 67% of our customers are on some form of auto-payment plan. However, I should remind you that it takes time to fully realize the pricing increases we recently implemented and we recognize revenue in each month or a 12 [ per ] time. We only expect about half of the price increase benefits to be realized in 2019, with full benefit coming in 2020.

Now turning to dynamic pricing, which, as a reminder, will allow us to model our cost and price sensitivity down to the ZIP Code plus four-digit level instead of the state-only level. By using the micro-geography approach, we can set prices to achieve more consistent gross profit margins versus the current state-level pricing that is commonly used by the industry. Additionally, it would also allow us to target lower-risk homes with lower price increases in order to maximize customer retention.

We're expecting to fully implement dynamic pricing over the course of 2019 as we build out the technology to support it. At this point, we expect dynamic pricing to increase gross margins by approximately 100 basis points on an annualized basis once fully implemented. Again, our goal with this effort is to gain more consistent margins across our customer base.

Our third strategic objective is to improve our business processes and contain costs. As I've previously mentioned, I'm relentless about our team managing the business to the inputs. Only by understanding the underlying data can we gain true visibility into how our business is operating and be more responsive to adjust and improve our operations in a real-time manner.

To that end, we have formed a project group which we have coined the tiger team that includes myself, senior leadership and key talents across the organization that is intensely focused on improving profitability for the company. This tiger team meets weekly to focus on driving operational improvement in our largest areas, which includes pricing implementation and managing contractor and parts costs. We prioritize initiatives that can make a measurable impact on the business as soon as possible. I can tell you there are several operational areas that have been operating the same way for years and this effort shines the spotlight on how we can improve them. We expect to utilize this tiger team approach to drive further benefits throughout the year.

One example of the tiger team's work is a revamp of our contractor selection algorithm, which selects the contractor firms that respond to service requests. We've made changes to the algorithm to ensure better utilization of our preferred contractor network. This is critical since our preferred contractors have labor rates that are nearly half that of other contractors in our network and also have superior customer service quality scores.

As I've mentioned previously, we send about 80% of our service work orders to our preferred contractors who comprise roughly 20% of our total contractor base.

Additionally, we are making progress on our appliance replacement versus repair ratio, which stabilized in the fourth quarter. We've worked with our contractors and part suppliers and improved our business processes to mitigate an industry-wide trend of more appliance replacements.

Now moving to our fourth objective, which is related to people and building a culture that enables our frontline employees to take increased ownership of customer issues. More fundamentally related to our people initiative, we're building a strong, action-oriented culture as a new independent company that other companies will envy and emulate. I should note that creating and establishing this type of culture does not happen overnight, nor is it single-faceted.

In 2019, we will continue to provide the necessary tools, metrics, reporting and resources to allow our frontline associates to make -- to take more ownership of the customer experience and reduce the layer of complexity that stand in their way. Besides obsessing about customers, one of our key leadership principle is to think like an owner, setting high standards for ourselves and our teams.

Technology advancement is our fifth strategic objective for 2019. As we've outlined in the past, technology is an area that has been underinvested over a number of years, and we're now focused on advancing our systems and platforms under Piras' leadership. Some of our key technology systems were developed in the early 1990s and over the course of 2019, we will continue to move to a cloud-based infrastructure, which will further enhance our ability to grow and scale efficiently.

As I've stated in our previous earnings call, we have a lot of work to do in this area over the next 6 to 12 months. I'm pleased with the velocity in which the team is making improvements by moving forward, but we're still in the early earnings.

Additionally, we remain excited about the possibility of leveraging the wealth of data we've collected over the years to further our efforts around dynamic pricing, providing insights on a geographic or ZIP Code basis, leveraging predictive analytics and eventually providing pricing transparency for customers. We continue to see areas of opportunity from a technology and aggregated data perspective that will allow us to leverage machine learning to improve how we manage costs and improve the overall customer experience.

Now moving onto our last strategic objective for 2019, our on-demand offering. As we've mentioned before, in 2019 we'll establish the on-demand playbook for the future. We view this year as an R&D year. We do not believe on-demand will have a material P&L impact in 2019.

We've made some key hires with pedigrees from top companies like Apple, Google, Amazon and McKinsey to develop and lead our on-demand effort. Once the playbook has been established and proven, we will scale the offering to major targeted cities in 2020 and optimize in 2021.

We're very excited about the opportunities that come with on-demand services and believe that this will be an integral part of Frontdoor's future growth and continued success. Our focus today on growing the already strong core business through technology and process improvements will lay the groundwork for the future of on-demand.

In closing, I hope you sense my passion and energy around making a significant number of improvements to the business in 2019. And I'm very proud of the efforts of the team this quarter. We are building a foundation in 2019 that will improve the customer experience, drive our financial performance and position us to continue to grow our core business and new on-demand services in 2020 and beyond.

I'll now turn the call over to Brian who will cover our fourth quarter and full year 2018 financial results in more detail and discuss our full year 2019 outlook. Brian?

[Brian Turcotte, executive]

Thanks, Rex, and good morning.

Please turn to Slide 7, and I'll briefly review a few key financial results for the fourth quarter 2018 and then dive deeper into the adjusted EBITDA drivers later in my comments on Slide 9.

Revenue increased 9% to $279 million, driven primarily by a 6% increase in the number of home service plans and the higher average price per plan compared to the prior year. Similar to prior quarters, our 9% revenue growth was comprised of 7 points of volume and 2 points of price. With the continued price optimization efforts Rex discussed earlier, we would expect price to represent a higher percentage of the contribution to growth in 2019.

I'll now provide more detail on the fourth quarter revenue contribution from our 3 primary customer channels of renewals, first year real estate and first year direct-to-consumer.

Revenue derived from customer renewals was up 10% over the prior year, due primarily to growth in the number of home service plans and an improved price realization.

First year real estate revenue was up 3% versus prior year, also driven by improved price realization, primarily due to a mix shift to higher-priced home service plan.

And first year direct-to-consumer revenue was up 9%, driven primarily by growth in new sales resulting from our ongoing investments in marketing.

In regard to gross profit, gross profit dollars increased 3% versus the prior year to $125 million, while our gross profit margin declined from 47% the prior year to 45% of revenue due to the higher claims cost that I'll review in a moment.

Net income was $17 million, down from $44 million in the prior year. This decrease was primarily driven by a $15 million increase in interest expense as a result of the debt offering we completed in August 2018. Prior to the spin-off, ServiceMaster's debt and associated interest expense were not allocated to our company, nor were we an obligor of that debt. Additionally, fourth quarter net income was impacted by a $13 million increase in tax expense versus prior year, primarily driven by a onetime $20 million benefit in 2017, related to the enactment of the Tax Cuts and Jobs Act.

Turning to Slide 8, I'll briefly review a few key financial results for the full year 2018 and again dive deeper into the adjusted EBITDA drivers later in my comments on Slide 10. Revenue increased 9% to $1.26 billion, driven primarily by a 6% increase in the number of home service plans and a higher average price per plan.

Again, looking at our 3 primary customer channels, revenue derived from customer renewals was up 10% over the prior year, due primarily to growth in the number of home service plans and improved price realization. First year real estate revenue was up 5% versus the prior year, driven by a mix shift towards higher-priced home service plan offerings. And first year direct-to-consumer revenue was up 8% due to the growth in new home service plans, resulting from ongoing investments in marketing.

In terms of gross profit, gross profit dollars increased 1% versus the prior year to $572 million, while gross profit margin declined from 49% in the prior year to 45% of revenue due to a $58 million increase in claims cost in 2018.

Net income was $125 million, down $35 million from the prior year. This decrease was primarily driven by the higher claims cost I just referenced and a $22 million increase in interest expense as a result of the debt offering we completed in August 2018.

Full year 2018 EBITDA of $238 million was significantly better than the top end of the revised outlook range we provided in early November. That outlook incorporated a pragmatic forecast that included the extreme temperature impact and the higher claims incidence rate that we had already realized in October that could have potentially continued throughout November and December.

While October exhibited the highest claims incidence rate in our 13-year modeling period, November was relatively in line with normal weather patterns, and extremely mild December temperatures resulted in the lowest claims incidence rate on record for that month. As a result, with a lower-than-expected claims incidences in the fourth quarter, we were able to smooth out our system capacity, operate more efficiently and more effectively deploy service request to our preferred contractors.

Additionally, we realized process improvements and cost savings in the quarter as the team began to make progress on the initiatives that Rex described earlier. The combination of better-than-expected weather, lower-than-expected claims costs and process improvement initiatives resulted in our exceeding the top end of our revised adjusted EBITDA range.

Now turning to Slide 9, the adjusted EBITDA bridge shows the drivers of change from the fourth quarter of 2017 to the fourth quarter of 2018. And I'll walk you through the details of the bridge. Starting on the left, we had $13 million of favorable revenue conversion versus prior year. We calculate revenue conversion as revenue from new customers, minus the related claims cost associated with new home service plans, plus the additional revenue associated with price increases.

Continuing to the right, the $9 million increase in claims cost is primarily related to the underlying cost of repairs, particularly in the appliance trade and heating, ventilation and air-conditioning trade or HVAC for short.

Sales and marketing cost increased $3 million due to incremental investments made to drive the 6% increase in the number of home service plans versus prior year.

We also invested an additional $2 million in our customer care centers to deliver an improved level of service.

The spin-off dis-synergies of $1 million relate primarily to the cost associated with separation of Frontdoor technology systems from ServiceMaster. And the $2 million of other costs are mainly higher professional fees in the quarter versus prior year.

Now turning to Slide 10, you'll see a similar adjusted EBITDA bridge showing the drivers of change for full year 2017 to 2018 and I'll walk you through the details of that bridge as well. Again, starting on the left, we had $64 million of favorable revenue conversion versus 2017. Continuing to the right, we had a $58 million increase in claims cost in 2018, which are broken into 4 key areas: first, $23 million relates to the higher underlying cost of repairs across all trades, particularly appliance and plumbing, primarily driven by inflation of labor and parts. Second, $17 million related to a higher number of work orders, primarily in the HVAC trade, driven by colder winter temperatures in the first quarter of 2018 and significantly warmer temperatures in the second and third quarters of 2018 compared to historical averages. Third, $15 million due to increased replacements, primarily in the appliance trade within the second and third quarters of 2018. As Rex mentioned earlier, our appliance replacement rate has stabilized, and we expect the current rate to continue through 2019. And finally, we had a net $3 million adjustment related to adverse development of prior year customer claims.

Now as we continue across the bridge, sales and marketing costs increased $10 million over the prior year due to incremental investments made to drive the 6% increase in the number of home service plans versus prior year. We also invested an additional $8 million in our customer care centers to deliver an improved level of customer service.

The spin-off dis-synergies of $4million relate primarily to the cost associated with the separation of Frontdoor technology systems from ServiceMaster. And the $5 million of other costs are mainly higher professional service fees and bad debt expense versus prior year.

Please turn to Slide 11 for review of our cash flow and cash position. Net cash provided from operating activities was $189 million for the year ended December 31, 2018, down $5 million from the same period in 2017. This decline is primarily due to a $7 million decrease in earnings adjusted for noncash charges.

Net cash used for investing activities was $10 million for the year ended December 31, 2018 compared to $11 million for the same period in 2017. The decrease is primarily due to increase in capital expenditures related to the spin-off, but it was more than offset by the sale of marketable securities, net of purchases.

Net cash used for financing activities was $165 million for the year ended December 31, 2018 compared to $68 million in the same period in 2017. The increase is primarily due to net cash transfers to ServiceMaster that occurred prior to the spin-off as well as payments for debt issuance costs incurred in connection with the debt offering completed in August 2018.

Free cash flow, which we calculate as net cash provided from operating activities minus property additions or capital expenditures, was $163 million for the year ended December 31, 2018 compared to $179 million in the prior year. This decrease was due primarily to an additional $12 million of property additions and lower earnings adjusted for noncash charges versus prior year. I should note that the EBITDA conversion of free cash flow was a very strong 68% in 2018.

We ended 2018 with $305 million in cash and marketable securities, a $54 million increase from October 1, after completing certain adjustments made in connection with the spin-off. Of the $305 million in cash and marketable securities, $187 million were considered to be in restricted net assets to remain in compliance with certain states' regulatory requirements, which is an $11 million decrease from October 1, 2018.

Turning to Slide 12, I'll cover our full year 2019 outlook. Revenue is anticipated to range between $1.35 billion and $1.38 billion and reflects our expectations that the high single-digit organic revenue growth exhibited in 2018 will continue throughout 2019.

Gross profit margin for 2019 is anticipated to remain consistent with prior year at approximately 45%, as the margin enhancement improvements that Rex mentioned earlier are mostly offset by ongoing claims cost inflation, including approximately $10 million in projected tariff costs.

Full year adjusted EBITDA is anticipated to range between $240 million to $255 million. I should mention that the adjusted EBITDA range includes significantly higher SG&A spend in 2019, as we invest in technology, sales and marketing, customer service and on-demand to drive growth and build a stronger foundation for the future.

Capital expenditures are anticipated to range between $30 million and $40 million, as we continue to invest in our information systems and technology platforms, including an investment related to our on-demand playbook. Overall, 2019 investment in the on-demand project will be in the neighborhood of $10 million, with approximately half recognized as capital expenditures and the remainder as operating expense.

The full year annual effective tax rate is expected to be approximately 24% in 2019.

Lastly, first quarter 2019 adjusted EBITDA is expected to be roughly in line with reported first quarter 2018 adjusted EBITDA despite the impact of increased investments in sales, marketing and customer service as well as projected tariff impact in the quarter.

With that, I'll now turn the call back over to Matt to open the question-and-answer session. Matt?

[Matt Davis, executive]

Thanks, Brian. [Operator Instructions] Please note that guidance is limited to the outlook we provided on our press release and webcast presentation. Operator, let's open up the line for questions?

[Operator]

[Operator Instructions] Our first question today is coming from Ian Zaffino from Oppenheimer & Co.

[Ian Zaffino, analyst]

Rex, thanks for the detail on the on-demand. Can you give us an idea maybe of what the R&D spend you're looking at over the next several years? You mentioned this year would be heavy R&D. Give us an idea of that. And also when we anticipate maybe a breakeven? Or what point does the product gain some type of critical mass? And then I have a follow-up.

[Rexford Tibbens, executive]

Yes, sure. So this is the year of R&D, as Brian pointed out. We're going to spend about $10 million this year to really build out the playbook. I think it would be premature at this point to kind of comment on when we may be breakeven because we haven't built the product yet. So I think as we build-out the products, we will get them over the course of this year. In 2020, we'll be then focused on target cities, the scale and then we'll optimize in 2021. So in terms of investment, we're comfortable with the $10 million this year. But then as we build-out those playbooks, we can then comment on kind of where we go from there.

[Ian Zaffino, analyst]

Okay. And also Brian, in the guidance, what are the assumptions for the real estate channel versus the DTC channel? And how do you sort of go about maybe mitigating any type of slowdown in the housing sales market?

[Brian Turcotte, executive]

Do you want to take that one, Rex?

[Rexford Tibbens, executive]

Okay. I'll take that one, too. For real estate, our focus is really renewed focus around our core markets. As we talked about on the call, continue to foster relationships with our leading brokerage firms. So really continue to drive penetration in those relationships and expand our market share. The other thing to point out is, if we do see softness, we have the ability then to pivot our marketing dollars or sales dollars from real estate to direct-to-consumer. So that's really our approach for real estate.

[Operator]

Our next question today is coming from Chris Gamaitoni from Compass Point.

[Christopher Gamaitoni, analyst]

Previously, you have guided to the long-term gross margin of 50%. I wanted to see if -- what are your updated thoughts on that? And does the 100 basis point improvement from dynamic pricing, is that added to that number over the long term?

[Brian Turcotte, executive]

Chris, good question. We still believe approximately 50% is -- attainable gross margin for us. As you can see from our guidance, it not going to be in '19, but going forward, we still think that's achievable for the business. And your second question was about dynamic pricing?

[Christopher Gamaitoni, analyst]

Yes. The dynamic pricing commentary was that it adds 100 basis points. Gross margin...

[Brian Turcotte, executive]

Yes, that will be on an annualized basis. We're not really building that into our outlook for '19. But going forward, that will certainly be something to help drive the business.

[Christopher Gamaitoni, analyst]

Okay. I was wondering this year, 2019 is obviously a year of investment, both on on-demand and across call center customer service. I was wondering, take out the on-demand side, but the core business, how long do you think it takes to get to call it a normal level of SG&A spend that beyond that it would just be normal inflation?

[Brian Turcotte, executive]

Well, if you look at our spend in '19, SG&A, we're spending more on marketing and sales to drive units, as I mentioned in my prepared remarks. We're going to continue to do that going forward. But I think going forward, we will get more flow-through from our revenue conversion than we are this year. We're making such a heavier investment and we're not getting the incremental margin we would normally get. But I think going forward, we will certainly get back to more normalized levels of revenue conversion.

[Christopher Gamaitoni, analyst]

Okay. And the -- this is...

[Brian Turcotte, executive]

In incremental margin, I should say.

[Christopher Gamaitoni, analyst]

From a corporate reporting standpoint, why not break out on-demand services into a separate segment just so we can kind of track? We understand it's the growth base and it's going to be in an investment period for a period of time, but just to separate it from the overall business. When at scale theoretically, there's different drivers and will probably be a reportable segment itself.

[Brian Turcotte, executive]

That's another good point, Chris. That could certainly make sense going forward. But again, as Rex said, '19 is a year of piloting, scaling next year and then optimizing the year after. So at some point, it certainly makes sense to break it out in the core business. Do you agree, Rex?

[Rexford Tibbens, executive]

I agree. Also, I would say that a lot of the technology, the work that we're doing is foundational for both our core business and on-demand. So even at scale, I don't think the 2 things kind of run separately. They rely on each other, right? So I believe we'll stay out of the way to separate those. We understand the growth of the core business. We understand the growth of on-demand.

[Christopher Gamaitoni, analyst]

And just one more, just from a philosophy standpoint, on your gross margin guidance, do you include some estimation of kind of adverse weather? Or you rely on historical average patterns?

[Brian Turcotte, executive]

Yes, we've got a 13-year historical model we use that we didn't tweak for most recent years, but we do see changing patterns as we have recently with some more extreme weather, for example, last year, both hot and cold. So yes, we do update the model as we go, but it's really based on 13 years of historical data.

[Operator]

[Operator Instructions] Our next question is coming from Jamie Clement from Buckingham Research Group.

[James Clement, analyst]

Can you hear me okay?

[Rexford Tibbens, executive]

We can.

[James Clement, analyst]

Okay, great. Brian, comments going back 3 months about the month of October and then you had some comments in the prepared remarks. Is it fair to say that for the year-over-year $9 million increase in claim cost, was that overwhelmingly tilted towards the month of October?

[Brian Turcotte, executive]

Yes, October was, as I mentioned in my remarks, was a really unusual year (sic) [ month ] that we started out with really warm weather that drove AC claims and then cold snaps across a lot of the country in the back half that drove the heating claims. So as unfavorable as October was on an incident basis, December was that favorable. So they canceled out and that's the disparity in our outlook versus our actual results. We thought that November and December could have a similar pattern to October and that's why we took a very pragmatic approach to our forecast that you saw on our EBITDA range we gave and you can see that December pretty much canceled out the unfavorability in October.

[James Clement, analyst]

Okay. And going back 3 months and I think possibly even 6 months, I think you all cited parts availability as being somewhat of a challenge. How does the process stand as either diversifying or expanding your part suppliers and that sort of thing?

[Rexford Tibbens, executive]

Yes. So from a business process perspective, I would say that we're managing to the inputs at a much greater level than 3 or 6 months ago. We look at all of our parts suppliers as well as parts down to the regional level. There, I think we've made great progress. I'd still, over the course of this year, I think we have even more work to do to continue to make sure we're managing to the inputs, but happy with the progress so far.

[James Clement, analyst]

Okay, great. I appreciate that. And then final question. In terms of the increase in SG&A from '18 to '19, are you -- can you bucket sort of those costs in percentage terms between, I don't know, maybe sales and marketing in one bucket, customer service in another and then on-demand in the third? Maybe that's not the right way to bucket them, but curious for your thoughts.

[Brian Turcotte, executive]

Yes, Jamie, this is Brian again. It's a great question. We didn't prepare -- give those comments in our prepared remarks. But let's think about, let's -- approximately 40% of the increase in SG&A will be related to sales, marketing and service. And the balance will be in the G&A bucket and that would include the synergies; technology spend, which will be a big part of our investment in '19; higher depreciation; et cetera...

[Operator]

Ladies and gentlemen, that concludes the question-and-answer session. I'll now turn the call back over to Rex Tibbens for some closing remarks.

[Rexford Tibbens, executive]

Thank you, again, for your interest in Frontdoor. We are building a foundation that will improve the customer experience, drive our financial performance and position us to continue to grow our core business and new on-demand services in 2019 and beyond. Thank you again and we look forward to updating you on our progress on our first quarter of 2019 earnings conference call.

[Operator]

Thank you. That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.